China's Healthcare Reforms
Addressing Discontent while Creating a Consumer Economy

March 7, 2013

A 2009 announcement by China’s central government of a sizeable investment in the country’s healthcare system was followed by commitments outlined in the twelfth five-year plan to boost the number of general practitioners and hospitals. More recently, an announced change to the country’s FDI catalog aims to further encourage foreign investment in China’s healthcare sector. In light of these developments, NBR asked Benjamin Shobert to provide background and perspective on what these new opportunities mean for foreign investors.

An Interview with Benjamin Shobert

By Sandra Ward
March 7, 2013

Market-oriented reforms in China that opened many industries to foreign investment and fueled spectacular economic growth have only relatively recently been extended to the country’s healthcare sector. Increasingly concerned about widespread dissatisfaction over quality of life despite the country’s rising GDP, China’s leadership has taken a series of steps aimed at improving the accessibility, quality, and affordability of healthcare.

A 2009 announcement by China’s central government of a sizeable investment in the healthcare system was followed by commitments outlined in the twelfth five-year plan to boost the number of general practitioners and hospitals. More recently, an announced change to the country’s FDI catalog aims to further encourage foreign investment in China’s healthcare sector. In light of these developments, NBR asked Benjamin Shobert to provide background and perspective on what these new opportunities mean for foreign investors. Mr. Shobert is Founder and Managing Director of the Seattle-based Rubicon Strategy Group.

What past attempts has China’s Ministry of Health made to privatize the nation’s healthcare sector, and what have been the results?

The most well known public-to-private transaction specific to healthcare that I am aware of is an attempt several years ago by the Ministry of Health (MOH) to privatize a group of several hundred underperforming public hospitals. At the time, the MOH’s idea seemed sound enough: these public hospitals represented necessary capacity the MOH was unwilling to take offline given China’s massive shortage of hospital beds. However, the hospitals themselves were in bad condition, both financially and operationally. Given that the hospital sector has long been a difficult one for overseas investors to access, and because China represents a potentially very lucrative private hospital market if the country could open to foreign expertise and investment, the interests of the MOH to unload some underperforming assets and a willingness by private investors to snap these up seemed to be aligned.

Private investors were under no illusion about the conditions of the hospitals; for many, early investments were always going to be loss leaders. The question was where and how much. Some investors probably hoped that by jumping on what the MOH was offering, they would be positioned down the road to have better access to more compelling privatization opportunities in the hospital space. What ended up happening was that everyone involved came out disappointed. The MOH may have privatized the ownership structure, but it forced the new owners to carry forward a number of legacy issues like pension obligations and handcuffs on how doctors and nurses could be managed. Investors were unable to make the sort of essential operational changes that were needed to become profitable. At least so far, it remains unclear if any of these investors gained an advantage with the MOH in ways that will matter down the road.

Why have attempts at public-to-private transitions in China’s healthcare sector been less successful than previous transitions in other sectors?

While the public-to-private transition in healthcare has been less successful, it is probably important to add the caveat “yet.” Other sectors that were opened as part of ongoing adjustments to China’s catalogue of foreign investment, such as retail, have had similar early struggles. Ultimately, what drove the reforms along in the retail segment was a combination of pressure by well-informed and savvy lobbying organizations like Wal-Mart and Carrefour. They had the size and the vision to understand that China’s retail sector was not going to simply spring open nationally on its own. They needed to take deliberate but forceful steps to pressure the Chinese government to open itself to their operations. Certain parts of healthcare have similarly sized and well-positioned organizations. The pharmaceutical sector, in particular, is at least as capable as the retailers just mentioned.

The second reason retail opening was ultimately possible was that China’s central government knew the role large retail conglomerates could play in driving down food costs, improving choices for consumers, and generally serving as stimuli for China to become a consumption-based economy. Those twin factors—the pressure by large retailers and the vision of China’s regulatory bodies—allowed the retail sector to open. Healthcare, however, is trickier than retail because the issues in healthcare are central to much of the discontentment that the Chinese government is fearful could lead to social instability or simply the leveling off of China’s amazing economic growth. Simply because the stakes are so much higher than in other sectors that have opened, it is only fair to acknowledge that healthcare remains a space in China’s economy that is likely to move more deliberately than others.

How has the international private sector responded to Beijing’s recent attempts to attract foreign investment in the healthcare sector?

The response thus far has been mixed. In a recent Harvard Asia Quarterly article, I call what is going on in China’s healthcare space “the promise and the peril.” Obviously anytime you discuss an opportunity in China, the size of the market makes people’s eyes swim. But the potential size of the market has to be weighed against the ability of a foreign entrant to profitably capture market share. In China, that is never a certainty; in a sector where the state’s interests are so much at stake, the role of foreigners will be heavily monitored and managed. Savvy investors know this. Relative to the public-to-private hospital transaction itself, the MOH has already shown a preference for Chinese conglomerates and investors from Hong Kong, Japan, and Taiwan. This reflects an appreciation on the part of the MOH that these investors have a better sense of the risks specific to this particular transaction and possibly even a general preference, given that many of these entities were involved in the MOH’s first aborted attempt at privatizing portions of the public hospital market.

Having said this, China’s healthcare space is seeded with a variety of American, Southeast Asian, and European companies and investment groups who are actively looking for possible investments to make. Existing players like Chindex, Parkway, Yodak, Raffles, WorldPath, and others will continue to expand into China’s private hospital market. New players such as Nashville-based Chinaco Healthcare Corp.—founded by the Frist family, who started the extremely successful Hospital Corporation of America—are bringing their first China facilities online in 2013. Chinaco’s market strategy will be interesting to watch unfold: the company is building a greenfield facility near Ningbo, while also participating in discussions to take advantage of the MOH’s public-to-private opportunity.

Your Winter 2012 Harvard Asia Quarterly article mentioned that the January 2012 shift of foreign ownership of hospitals from the “restricted” to the “encouraged” category in China’s catalogue of foreign investment opened up the possibility of 100% foreign ownership of healthcare institutions. Is this an indication that the government lacks confidence in the capabilities of the Chinese private sector? Is Beijing seeking expertise as much as investment dollars?

I don’t believe this change signals the central government’s concern that China lacks investment money. If anything, capital is the one resource in this scenario that China has in abundance. What Beijing is concerned with is attracting investment where it is needed the most. To reduce this to a very simple way of thinking about things, the more private money China can attract into the primary care, clinic, and hospital sector, the less investment the Chinese government has to make. When you consider the extraordinary gaps in access to and coverage of basic healthcare in rural China, finding ways to incentivize foreign investment into the urban areas where China’s newly minted middle class can be found is a smart idea. Does the country need the investments to come from outside? No. China is not short of investment capital. But timing is an issue, specifically the need to improve rural healthcare as quickly as possible.

Your question gets to what is probably the deeper motivation: China needs outside expertise as much as anything. One of the key questions involving China’s healthcare reforms is whether the country can absorb not only the technology of modern healthcare but also the many intangibles that go into competently (not to mention profitably) delivering healthcare today. A great example of this is healthcare IT (HIT). This may surprise some, but China has one of the more sophisticated HIT infrastructures in the world—at least in theory. The country’s hospitals have been fairly aggressive when it comes to tracking down, purchasing, and installing state-of-the-art HIT. However, problems have arisen in acquiring all the follow-on services that allow an HIT system to deliver what it promises. Within China’s business culture, there has been a reluctance to pay for services. The sort of intangible expertise that allows an installed HIT system to function gets easily devalued in China. This is just one example of where China needs foreign entrants to illustrate not just how to buy and install the right technology but how to use it. Beyond this, managed care systems in the United States have a lot to offer China relative to how to look at healthcare costs in a holistic sense. Something like the PACE Model, an all-encompassing elder-care treatment methodology that is growing in use within America, could have a massive positive impact on China’s elder-care crisis. If China is smart, it will embrace these insights and work to build models that utilize the sort of healthcare delivery and cost-effective reimbursement schemes coupled to new technologies the United States is only now fighting to make reality.

Does the international private sector have a strong interest in full ownership, or is there a preference for joint ventures with the Chinese private sector?

This question is actually a little tricky to answer. The international private sector has a very strong interest in full ownership, or what China calls “wholly foreign-owned enterprises” (WFOE). The challenge in any sector of China’s economy newly opened to foreigners is that a joint venture (JV) is almost always necessary to navigate the many gray areas where regulations may not exist or where they do exist and may work at cross-purposes with what private investors need in order to operate profitably. A JV may become necessary simply because to go it alone, while procedurally possible, is practically impossible. In other cases, healthcare entities may find they need a JV in order to access land rights or obtain particular approvals. Neither of these obligations come from formal regulatory barriers; rather, they are all informal conditions that exist in the early period before well-established market characteristics where clear roles for government, private insurance, and industry to play have been defined. People talk about how navigating China’s informal, relationship-driven networks is about guanxi (“connections”), and they are never more right than in sectors where the state has a strong interest (like in healthcare) and where the space has only recently opened to foreigners. If healthcare in China evolves and opens in ways similar to other sectors, then foreign entrants who initially found a JV was necessary—even if not obligatory—will, as they become more comfortable navigating China, likely either exit their JV partnership or restart as a WFOE.

How will the international pharmaceutical industry likely respond to China’s efforts to encourage strategic partnerships with the Chinese private sector?

The pharmaceutical industry has its hands full in China. We can get the obvious out of the way: the future for international pharma is pretty bleak absent the top-line growth opportunities generated by selling into China. But accessing China will become more complicated, not less, for pharma companies over the course of the next several years. Last year China changed its patent laws to allow for compulsory licensing, which is when a country basically forces a pharma company to license its drug-manufacturing technology to the state. This is allowed by the WTO in cases of national security or nationwide emergencies. It is something India has done, but China had left it alone and elected to modify its patent laws to make room for compulsory licenses. The fear has always been that countries would abuse compulsory licensing. So far, that has not been an issue globally. China’s rush to develop a domestic life science industry always brings out those who fear something like compulsory licensing could be used to transfer technology to China’s domestic drug manufacturers. Again, that has not happened thus far, and most in the industry do not believe such actions are likely.

During roughly the same period last year when China changed its patent laws, a group of about twenty high-margin branded generics that multinational pharma had enjoyed secured pricing on in China for about twenty years ended, opening these therapies up to foreign competitors. The expansion of China’s national formulary, through what is called the Essential Drug List, has resulted in the price of many drugs dropping precipitously. In addition, the twelfth five-year plan explicitly calls out life sciences as one of the strategic emerging industries that China wants to see develop domestically. This means pressure on international pharma to do more core R&D in China and that more technology transfer obligations are likely to present themselves over the course of the next several years. None of these challenges are insurmountable, and it would even be fair to say that China is approaching pharma in much—if not exactly—the same way as it has approached other industries where it traded market access for technology. What we can say is that pharma is facing a more complex environment in China than ever before, and that in order for international players to be successful they must manage very critical strategic issues like those mentioned earlier with basic tactical considerations such as how to sell into China’s changing hospital market and how to effectively lobby a highly fragmented policymaking and reimbursement system.

What more could foreign investors interested in opportunities in China’s healthcare sector learn from the intersection of Chinese and international business interests in other sectors of the economy?

This is not the most elegant answer, but “patience.” If we look at other sectors of the Chinese economy that opened to foreign investment, we certainly see very large multinational companies with experience and the balance sheets to absorb setbacks in the pursuit of a dominant position in their market of choice. Many of these firms were okay with buying out their JV partner down the road or exiting a JV relationship that no longer fit. These are typically very expensive options. Not everyone is Coca-Cola, however. Being patient, staying connected to what is going on in the market, and perhaps most importantly, knowing your company well enough to understand when the risk premium of not going in outweighs that of observing are lessons foreign investors in a sector like healthcare should heed.

Benjamin Shobert is the Founder and Managing Director of Seattle-based Rubicon Strategy Group, a boutique consulting firm specializing in market access work in China’s healthcare and senior care industries. He is a member of the National Committee on U.S.-China Relations and holds an advisory board seat at Indiana University’s Research Center on Chinese Politics and Business. In 2012, he became a member of the Pacific Council on International Policy. For over six years he wrote a weekly column for the Asia Times on U.S.-China trade and economic policy matters, with a particular focus on how relations between the two countries are being impacted following the 2008 financial crisis. In addition, his work has been featured at CNBC, China Business Review, Harvard Asia Quarterly, and Fortune Magazine (China), and he is a columnist with Forbes China.

Sandra Ward is Director for Communications and Brand Development at NBR.